7.4.2.2 The Marginal Costs of Public Funds

As noted in Section 7.2.4 shadow prices have to be applied
to market prices when these prices do not reflect the true opportunity costs.
Shadow prices have also been applied to the funds used to finance mitigation
programmes. Public expenditures, regardless of the benefits they confer, impose
a cost on society, which reflects the marginal excess burden of
a tax policy. The marginal costs of public funds should include the impacts
of eventually reduced distortions compared with existing tax systems, as well
as administration costs, compliance costs, the excess burden of tax evasion,
and avoidance costs incurred by the taxpayers. Slemrod and Yizhaki (1996) also
suggest the distributional impacts of public funds collection be included.

The marginal costs of public funds are critically dependent on the dead-weight
loss associated with distortionary taxation, which is dependent on the specific
tax structure in place in the non-policy case. To evaluate the true social cost
of the funds it is necessary to estimate or know the marginal cost of public
funds, that is the cost per dollar of finance, which is greater by US$1 than
the welfare cost of raising the tax revenue. In general there will not be one
figure for this cost for the whole tax system. Each source of finance will have
its own marginal cost. In general there will not be one figure for this cost
for the whole tax system. Each source of finance will have its own marginal
cost15.
If such a correction is not made, mitigation policies underestimate the costs
of reducing GHGs.

Håkonsen (1997) has surveyed the theoretical discussion of the marginal
cost of public funds, and empirical estimates of the marginal costs have been
made by the World Bank and others (Devarajan et al., 1999, European Commission,
1998, Ruggeri, 1999).

Estimates tend to suggest that the marginal costs of public funds are larger
in developing countries than in developed countries. Devarajan et al. (1999)
estimates that these costs vary between US$0.48 and US$2.18 for developing countries
and US$1.08 and US$1.56 for the USA. The European Commission uses a value of
US$1.28 for the shadow price of public funds.